Apple, Google: Fraud Worries Obstacle To NFC, Says Morgan Keegan

By Tiernan Ray

Folks, I must admit that in the debate over “mobile payments,” I’ve been out of touch, of late.

Today, for example, I neglected to mention a longish note — 29 pages — that came out late Monday from Morgan Keegan, assembled by Tavis McCourt, who follows Apple (AAPL), as well as some colleagues of his, Matt McKee, who follows communications technology, and Roberd Dodd and Robert Ladyman, who follow transaction processing.

The note’s interesting, so I thought I’d mention it, even though I missed my chance earlier.

The authors offer the view that there is “substantial” potential for near-field communications (NFC) chips embedded in a phone as a mobile “digital wallet.”

But the obstacle is that the status quo is likely to prevail, basically because of the risk of fraud.

Merchants are likely to take awhile before they will move to NFC. Why? Because the most likely method of funding a mobile wallet, by tapping into a bank account, called “ACH,” doesn’t actually clear the funds till an overnight update happens, unlike traditional debit cards, where money is cleared right away. Which means merchants can be left hanging when there are insufficient funds.

Unless the banks can underwrite/insure the funds to protect against fraud, in a cost-effective manner for merchants, than the status quo will prevail, which means digital wallets will just be a thin layer riding on top of the current payment system of the “networks” — Visa (V), MasterCard (MA), etc.

And in that system, Visa and MasterCard still make most of the money. Which means little actual direct share of profit for Apple, Google (GOOG), and other smartphone vendors.

“The mobile payment opportunity is more of a cost burden than a real benefit” to Apple and others, they write. Putting an NFC chip in a handset can cost $2 to 4$ per handset, they note. Apple and others might not get any share of the actual transaction dollar amount, they argue.

One real beneficiary of any NFC buildout might be VeriFone (PAY), which already sells terminals for credit-card processing. They’ll have to supply merchants with point-of-sale terminals for the buildout of NFC. Morgan Keegan rates VeriFone’s shares Outperform.

The Morgan Keegan note echoes a lot of skepticism voice Monday by Toni Sacconaghi with Sanford Bernstein, who follows Apple. Among his concerns is that putting those NFC terminals in retail locations could take five years or more to happen.

And then putting an NFC chip in the iPhone could add $450 million to $900 million to the cost of goods for the thing Apple’s 2012 fiscal year, which could lower Apple’s gross margin by 0.4 to 0.7 percentage points. Then, too, it’s unclear if Apple and others could command a meaningful cut of the transaction, as McCourt and company point out.

Sacconaghi concludes we won’t see NFC in Apple’s next iPhone: “We do not expect the iPhone 5 to feature an NFC-based payments solution, and instead expect Apple to evaluate and come to market with partners or a complete solution later, perhaps when NFC infrastructure is more established.”

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There are 3 comments

MAY 18, 2011 1:49 P.M.

AdamAnt wrote:

"And in that system, Visa and MasterCard still make most of the money." Is inaccurate. The majority of the Interchange fees goes to the Card Issuing Banks (Chase, BofA, etc). V and MC only make a small portion of the overall cost in what's called "Dues and Assessments) - Which is < .5% of the overall cost.

MAY 26, 2011 2:13 P.M.

thorazine wrote:

Teirnan, your article shows that you don't understand the payments processing system. Visa and Mastercard DO NOT make "most of the money" as you say. The "issuing banks" and the "acquiring banks" make most of the money. Visa and Mastercard's proportion of a typical transaction is less than 15% of the Fee charged to the merchant. The one making the most money (60% of the charge) is the issuing bank (Citibank, Bank of America, etc) who Issues the card and takes on the fraud risk. Visa and Mastercard are Intermediaries who process the transaction, handle/collect the money, and make payments to the various parties in the transaction. You need to read an in depth report on the payment processing industry. good luck.

MAY 26, 2011 3:05 P.M.

Tiernan Ray wrote:

Thorazine: The contention is not mine, its Morgan Keegan's. The report acknowledges, as you say, that the networks -- V, MA, AXP, DFS -- only get a fraction of the transaction. The statement that they get "most of the money" is in this case meant to distinguish what V and MA would get for the transaction compared to what an Apple or Google might get. The other point is that V, MA, DFS and AXP have a greater ability to scale with transactions because they service multiple different issuing banks. In other words, it's not just the percentage of the take on each transaction, it's the money made off the total volume of transactions, worldwide. Also, when one talks about how much value accrues to these institutions, bear in mind that the profit for a network can be a lot higher than for a bank. Citi made $16.6 billion in revenue in 2010 from Citi-branded cards. They made just $1.54 billion in operating profit from that, or roughly 9%. Visa, on the other hand, made just $8.1 billion in revenue, but they made $4.6 billion in operating income off that, or roughly 57% margin.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.